Small-cap stocks have suffered compared to their large-cap brethren in recent years, but Needham Aggressive Growth Fund (NEAGX), managed by John Barr, has shined.
It has annualized returns of 22.88% for the last three years through March 13, 12.92% for five years and 12.73% for 10 years, according to Morningstar. That puts the fund in the 5th percentile or better for all three periods among small-cap growth mutual funds tracked by Morningstar.
Barr’s philosophy is to find undervalued growth companies with hidden value, say a new investment, and then hold them until the value is recognized. He likes small-cap growth companies because so many are undiscovered by other investors.
The fund manager is now attracted to companies involved with “picks and shovels,” by which he means infrastructure. It’s companies constructing buildings, roads and ports. And it’s ones making hardware for data centers and research instruments for life science companies.
Here are Barr’s comments, including stock picks.
TheStreet: What’s your investment philosophy?
John Barr: We look for hidden compounders [that will transition] to quality compounders. [By “hidden compounders” he means companies with overlooked strengths. And by “quality compounders,” he means companies that will grow consistently over the long term”]
There is hidden high return on capital. Maybe the company is investing in a new business. But the results aren’t there today. When new things happen, you get earnings. We like to see progress within two to three years. But it doesn’t have to come through in financials yet.
The market rarely looks beyond a quarter or two. We hold the stocks as they turn to quality. We don’t have much turnover. It was 11% in the trailing 12 months. We want companies that grow to five or 10 times their current size. And we buy with a margin of safety to protect the downside.
TheStreet: What do you like about small-cap growth stocks?
John Barr: They are less followed, receive less attention [than large-cap stocks]. It’s a less efficient market. In a few cases, I’m one of only a couple investors who has a model for a particular stock. If I’m right, we can be early and should get a good return.
Needham Funds
TheStreet: What areas of small-cap growth stocks are most attractive?
John Barr: Investments in picks and shovels: infrastructure. That includes technology, such as hardware for data centers, and research instruments for life sciences.
There’s physical infrastructure, including roads, ports, buildings and national defense. Improvement of local supply chains and domestic manufacturing is an issue too.
The U.S. is underinvested in manufacturing. There could be a long tailwind in manufacturing and reshoring. [Reshoring means the return of U.S. manufacturing from overseas].
The latest area is artificial intelligence. The computer power required for AI is incredible. That’s good for hardware supplied to data centers and for semiconductors.
TheStreet: Can you talk about two of your favorite stocks?
John Barr: Clean Harbors (CLH), which fits the reshoring theme. It’s trading at 17 times earnings, which is a 20% to 30% discount to two of its larger peers: Waste Management and Republic Services.
Clean Harbors is the largest hazardous-waste disposal company in the business. It also treats and resells used motor oil. It has the greenest way possible to produce domestic oil.
It has nine incinerators and nine landfills. That gives it a No.1 market share in incinerators, and it’s tied for No. 1 in landfills. There is no one better to treat forever chemicals.
As environmental awareness and regulation spread, more hazardous waste needs to be treated, and no one is building new facilities.
They’ve had good returns in the last three to four years and can expand their margins. The industry was fragmented in the past. But now it has consolidated, and Clean Harbors is the main consolidator.
TheStreet: What’s the other stock?
John Barr: Parsons (PSN). It’s an engineering and construction management company. Its federal systems unit builds airports, bridges, tunnels, roads and rail. Its technology helps protect missiles, satellites and planes. It provides high-level cyber defense analysis through high speed data collection.
The Defense Department’s Missile Defense Agency is Parsons’ longest customer at over 30 years. Parsons has contracts to protect missile bases in Europe and Africa. It’s a small player in a large market.
TheStreet: How do you deal with the volatility of small-cap growth stocks?
John Barr: Knowledge of the company is really important. If you have a good thesis, then stock-price volatility shouldn’t lead to an impairment of capital.
Historically we have good downside results. We buy with a margin of safety. We’ve held about 50% of our stocks for five years or more. After our thesis is in play for three to four years, companies are generally showing good growth, which serves to limit the downside.
It’s also important to make sure you have the appropriate allocation to small-cap growth based on your risk profile, objective and time horizon.
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